Tuesday, July 10, 2012

House
Financial Services Committee Chairman Spencer Bachus (R-AL) kicked off a series
of hearings on the two-year experience of the Dodd-Frank Act by urging the Senate
to pass legislation, HR 2682, codifying and clarifying the end-user exemption from
Dodd-Frank derivatives regulation. The House passed the Business Risk
Mitigation and Price Stabilization Act by a bi-partisan vote of 370-24 on March
26, 2012, but the bill has not been taken up by the Senate. More broadly, the
securities industry expressed concerns that the ``flawed’’ CFTC guidance on the
cross-border application of Dodd-Frank derivatives regulation could isolate the
US swap market by creating two sets of swap regulations and, more specifically,
that the substituted compliance approach could lead to fragmentation as firms establish
entities in many jurisdictions.

Similarly,
Rep. Robert Dold (R-IL) urged prompt action on the Swap Data Repository and Clearinghouse
Indemnification Correction Act, HR 4235, has been approved by the House Financial
Services Committee by voice vote on May 9, 2012. HR 4235, which is bi-partisan
legislation co-sponsored by Rep. Dold and Rep. Gwen Moore (D-WI), would repeal the
indemnification provisions in Sections 725, 728, and 763 of the Dodd-Frank Act to
facilitate global regulatory cooperation and ensure that U.S. regulators
have access to necessary swaps data from foreign data repositories, derivatives
clearing organizations, and regulators.

Sections 728 and 763 of the
Dodd-Frank Act require swap data repositories and security-based swap data
repositories to make data available to non-U.S. financial regulators, including
foreign financial supervisors, foreign central banks, and foreign ministries.
Before a U.S.
data repository can share data with a foreign regulator, however, the foreign
regulator must agree that it will abide by applicable confidentiality
requirements that it will indemnify the data repository and the SEC and CFTC for
litigation expenses that may result from the sharing of data with the foreign
regulator. Section 725 of the Dodd-Frank Act imposes similar requirements for
data sharing between derivatives clearing organizations and foreign regulators,
including the requirement that foreign regulators indemnify derivatives
clearing organizations and U.S.
regulators for litigation expenses that may result from the sharing of data
with foreign regulators.

According to Committee
Report No. 122-471, accompanying HR 4235, these indemnification provisions threaten
to make data sharing arrangements with foreign regulators unworkable. Foreign
regulators will most likely refuse to indemnify data repositories, derivatives
clearing organizations, or their U.S. regulators for litigation
expenses in exchange for access to data. As a result, foreign regulators may
establish their own data repositories and clearing organizations to ensure they
have access to data they need to perform their supervisory duties, which would
result in the creation of multiple databases, needlessly duplicative data
collection efforts, and the possibility of inconsistent or incomplete data
being collected and maintained across multiple jurisdictions.

The security
industry is generally concerned with the cross-border implications of
Dodd-Frank regulation of derivatives. SIFMA senior official Ken Bentsen said
that the
initial reading of the recently proposed CFTC guidance appears to be that the extraterritorial
application of U.S.
regulations could create two sets of rules for swap regulation and could
isolate the U.S.
swap market from the global market. If transacting with a U.S. financial
intermediary or end user puts non-U.S. entities at risk of becoming subject to
U.S. regulation globally, cautioned SIFMA, it is clear that such non-U.S.
entities will not transact with U.S. entities, denying U.S. firms access to
those global markets. This will raise the cost of hedging, warned SIFMA, and if
the cost is prohibitive, will lead U.S. firms to decide not to hedge.

SIFMA also noted that the recently
proposed CFTC cross border guidance is complex, expansive in scope, and highly
prescriptive. It is unsure that the terms of so-called substituted compliance, which
theoretically should allow market participants in other well regulated markets
to rely on their home market regulation, would actually work in practice.

This substituted compliance process will be
different than the mutual recognition model, observed SIFMA, and would require
the CFTC to individually review the rules of foreign nations. The industry is
concerned about determinations of cross border equivalence that are not
outcomes based, but used instead
as a tool to export regulations from one jurisdiction to another. If a host
country regulator were to extend certain regulations to the global entity, reasoned
SIFMA, the entity would be subject to overlapping and potentially inconsistent
regulation.

In
such an event, the non-U.S. entity may decide that the easiest way to comply
with each jurisdiction’s requirements is to register separate entities in many
more jurisdictions than it otherwise would. This fragmentation of global firms
could lead to inefficient results. With respect to capital, for example, it
would remove the benefits of netting, collateral management and centralized
risk management, which are key components of systemic risk mitigation.

Further,
SIFMA believes that the CFTC’s cross border application approach is flawed in
that the Commission chose to do so in the form of guidance as opposed to a regulation,
and apparently, without sufficient coordination with the SEC. By failing to put
forth a regulation, the CFTC avoided conducting any cost-benefit analysis and
formal comment by affected parties. SIFMA believes that a more holistic,
rules-based approach, as it understands the SEC is likely to do after all of
the Title VII rules have been proposed, is a more prudent approach.